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Monday, March 18, 2013

Is Cyprus the Bad News We Were Watching For?

In Friday's update, I noted the charts were suggesting
a turn was approaching, and I speculated that there would be some type of
"bad news" event hitting the press this week; I went a
step further and speculated that the source of the news event might be
the FOMC meeting on March 20. Score one for my interpretation of the
charts -- but score zero for my speculation as to the source of the
pending bad news (though, to be fair, it remains to be seen how my speculation
regarding the Fed will pan out – though, I suspect the events of this weekend
may alter their game plan).

As it turns out, the source of bad news seems to have been a
tiny country known as Cyprus, which is apparently part of the European Union,
and in need of a bailout (act surprised!). I'm not going to berate myself
for failing to include "bad news from Cyprus" in my speculations --
prior to this weekend, if someone had asked me to relay the
totality of my personal knowledge regarding Cyprus, I would have
said it was "probably some kind of tree." If
pressed, I'd have added, "Or maybe a rap singer and/or the
newest car from Hyundai."

What's unique and frightening about the goings-on here is
that the EU has asked Cyprus to levy a tax on the bank accounts of private
citizens to help fund the bailout. Todd Harrison has
written an excellent piece discussing all this in more detail (See: Cyprus:
Has the Next Phase of the Global Crisis Arrived?).

There are legitimate concerns this will set off bank runs
across the Eurozone. One thought I would add to this discussion is
that it's my belief that -- short of systemic
failure, anyway -- European instability is actually bullish
for U.S. markets. This may be counter-intuitive, but if the EU
experiences bank runs, it's not as if European investors are going to
withdraw all that cash and simply bury it in their backyards.
The cash has to go somewhere. Ask yourself: If you were a European
investor who felt your money was unsafe in Europe, where would you put
it?

Right or wrong, bubble or not, the U.S. treasury market and
blue chip equities are still perceived as "safe havens," especially
when seen in contrast with Europe. So some portion of any massive
capital flight out of Europe is almost guaranteed to
find its way into U.S. markets. That means even more liquidity
flowing in, on top of the Fed's existing support. More fuel for the
fire would help drive down treasury yields and help drive up
equities.

It's all relative, after all -- and basically,
we're still the prettiest ugly kid on the block.

If you are truly aware of the challenges facing the
world, it's logical to have a tendency to be bearish these
days. The danger for bears is it's tempting to view events like this
as "confirmation" of a pre-existing bias, which can lead to
over-trading one's convictions. Believe me, my "inner
bear" wants to pounce all over these types of events, too.

Could this be the watershed event that leads to a prolonged
bear market? Sure, anything's possible -- but given how much liquidity is
still flowing from the Fed, I think this event is
probably simply yet another warning signal of an
approaching storm. I suspect the storm hasn't actually reached
us yet... in fact, based on the most probable interpretation of the charts
(in my opinion, anyway), it's still some ways away.

If you're prone toward a bearish bias, just remember to
consider both sides of the equation. Bears tend to look at events like
this and think: "Storm coming! And nobody wants to be the last guy
standing on the beach when that hurricane rolls ashore!"
But bulls think differently. A bull would say, "Sure.
But then, nobody wants to cut short their vacation for a false alarm,
either!"

I covered my views on this psychology fairly well in an
article in January -- one of my personal favorites of the articles I’ve written
this year. It's titled A
Survival Guide for Bears in a Bull's World. If you're aware of all
the trouble in the world and are thus prone toward an intelligent fundamental
bearish bias, I'd highly recommend giving it a quick read.

Let's move on to the charts. The charts have been
hinting that a correction was looming, which led to my speculation on
Friday that bad news was forthcoming this week.To be fair, I was expecting about 6 or 7 more points out of this
rally, but it remains to be seen if the market will achieve that or
not. For a wave as large as this rally, a peak that falls 6-7 points
shy of targets would be well within the margin of error. So on the
chart below, I have kept Friday's alternate count (of wave 5 complete at
1563.62) unchanged in the labeling, but the odds on that count must be
considered at 50% after the overnight futures sell-off.

Since the two counts are being viewed as equals, the chart
below shows how the wave could be viewed as entirely complete. We'll
simply have to see how the cash market responds today. In any case,
hopefully my warnings of the past several days have helped readers protect
themselves and lock-in profits.

In conclusion, I wrote on Friday that I was on “high alert”
for a turn, so the bad news out of Cyprus isn't entirely unexpected. The
news fits the charts, which continue to suggest bears may get a solid, scary
correction here. It's still too early to determine much in the way of
probable targets, or even to sort out if this is the smaller degree fourth wave
-- but if we've indeed seen the completion of the fifth wave in its entirely,
then the high 1400's would be entirely reasonable. Ultimately, however, I
presently do not believe this will mark a long-term
peak, though the market always reserves the right to change my mind. In
any case, after we see how the cash market responds, I may be able to
generate some preliminary near-term targets for the next update.
Trade safe.

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